Creating a Law Firm Profit Culture

Image [cc] evan p. cordes
One of the biggest question marks in the legal industry is around driving change in law firms. We all know change is needed, but it tends to come very slowly for law firms [insert shocked exclamation here, soaked in sarcasm]. There are a number of classic law firm change methods in use, but none tend to increase the rate of change at a level consistent with change in the real world. I suggest fear as a strong motivator and fear around money as the penultimate motivator.

And this is where profitability comes in.

We've covered the subject of profitability in the past about what it is, but here I want to suggest it as a tool for change. More specifically, law firms should create cultures of profitability in order to drive change.

The Profit Methodology

The first step in creating a profit culture is deciding on a profit methodology. This first step can be the one that brings the entire effort to a grinding halt. Partners can easily see that any profit method will eventually impact them, so they spend hours arguing about what it should or shouldn't be, trying to tilt the model in their favor. This is of course understandable. However, given the proclivity for and skill in arguing lawyers possess, having all of them engage on this at once is what usually kills the plan. In actuality, a given model favoring one partner over another is so minuscule, the arguments are not worth making. But remember our guiding light about fear over money, and you will understand this behavior. So the solution is helping partners understand the low value of arguing and that the real goal is having a method that is not focused on an unachievable, absolute profitability, but instead on one that is instructive for how partners can improve profit.

I won't go into detail here, but there are three basic profit methodologies a firm can utilize:
  1. Contribution Margin, 
  2. Gross Margin, and
  3. Net Margin. 
Each model treats partner compensation in a different way, either treating all as:
  1. a Labor Cost,
  2. All as Profit, or 
  3. has some method for segmenting a portion as cost, leaving the rest designated as profit. 
Which ones firm picks is not as important as just picking one.

Once a firm moves past adopting a methodology, they move on to step two.


In this step it needs to be somebodies job to go around the firm presenting and talking with partners about the profit methodology. Relatively simple presentations showing how the model works for various types of work should be given. And then given again and again and again.

An ideal person for this is a pricing director, since they are in a primary role on this subject and over time will be the person who puts this all into action. Absent that, someone with a finance role will work, provided they present well to partners.

Step two is never done, since partners need to hear this message a few times for it to sink in. And firms are always adding new partners to the roster.


Once we have some reasonable level of understanding, then a deeper education effort should be made. This puts the model into action with partners' own financial information. This can be done with pricing requests or even better, with existing, ongoing matters. As we all know, clients are keen on cutting spend, so many matters have budgets or caps or some other fee deal that require partners to stay on top of fees. This is a great opportunity for them to see profit in action.

Throughout all three steps in this process, firm leadership should be supporting and sharing the message in firm-wide situations and in practice group meetings. In the third step, education can be done in individual partner evaluation situations too.

The Compensation Caution

When a firm pursues this path, they should be prepared for the compensation questions. Once partners figure this all out and understand that the way they price and manage their work drives profit, they will want to know how and if this all will impact their comp. Most firms at this point in time do not factor profitability in to individual comp. Even under this circumstance, it's relatively easy to talk about how a rising tides raises all boats. And that story is going to be a good one to tell throughout this entire journey. The real goal of a culture of profit is not beating up people with marginal numbers. Instead the real goal is driving the whole range up.

Lawyers tend to see things in black-and-white, so they may see any numbers below an average or benchmark as failing. Throughout this culture change effort, you would do well to use the message that the goal is to increase profit across the board. You will have matters with high profit that can be made more profitable with minimal effort. Just because one is above average does not mean one has reached their potential. Of course you will find some work with "negative" profit. Be prepared for that. Firms chose to have a range of practices for many reasons beyond the profit of specific work.

As firms go down this road, it will raise new debates and discussions within the partnership. Firms will face new questions and may not have immediate answers. This is part of the value of creating a culture of profit. These are discussions you need to be having, but have been avoiding. The results will be a financially healthier firm. But a firm will need to be prepared and willing to openly discussing the new issues that come up.

Hit the Road

You may be thinking this road to profit sounds a bit bumpy, and you would be right. However, here's the deal: You have to go down this road. Firms that avoid or delay this quest will be significantly handicapped in this changed, competitive legal market. Long-term, they will likely go under or at a minimum, be marginalized as lower profit firms.

Change is as Change Does

The real power of the profit culture comes in to play in driving change. People love to talk about all of the change that is needed in the legal industry. It's been a while since I heard anyone say AFAs were a passing fad or that clients are going to pull back from discount requests. But even with the need for change being common knowledge, change is coming too slowly.

With a profit culture in place a firm creates a sense of urgency around change. Partners now have a clear reason to adopt change. It will no longer be a theoretical good idea, it will become an obvious, pressing need. Partners will now know what drives better margins and what they need to do to attain them. More importantly, they will know that everyone else also knows this and what their grade is within the partnership. And we know how type-A lawyers are. Having low profit numbers is like getting a C- in a law school class. No lawyer wants that grade, especially when your peers will see it.

So - putting this all together, creating a culture of profit is necessary for law firms that want to thrive or even survive. It will be critical to their ongoing financial success and it will drive the change they desperately need to stay competitive in the market. As an added benefit, it will drive cost savings for clients.

So why aren't all firms doing this?

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Jack Bostelman said...

I agree completely that law firms should calculate and share with partners information about the profitability of matters, not merely billings or realization rate (which address only the revenue side of the income statement). In my opinion, firms should all be incorporating profitability metrics into the key financial data they share with all partners. And, as you say, an education program needs to accompany this effort.

As I was cautioned by a successful law firm leader, however, taking the next step of tying compensation to this metric needs to be handled delicately. Arguments against doing so include potential disruption to an otherwise stable and successful culture, possible gaming of the system and subjectivity of the calculation. Arguments favoring tying compensation to profitability include the very real fact that even law firm partners are rational beings when it comes to compensation and will pursue matters that are more profitable if that's how they are compensated. I discussed these factors in a blog post of my own: http://www.kmjdconsulting.com/can-profitability-be-gamed. Each firm has to find its own balance of these factors in deciding whether and how to address matter profitability in its compensation system.

Keep up the great posts!


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